The never-ending banking story

It’s a never-ending story. The global banking sector remains deep in the sludge of scandal, corruption and mismanagement. It continues to fail in its supposed purpose, namely to provide liquidity and credit to households to buy ‘big ticket’ items (or even cover monthly outgoings) and to businesses to enable them to pay for working capital and investment to grow. And yet in 2012, bank share prices have rocketed by over 25%, more than the booming stock market indexes.

During the financial collapse of 2008, the US banking industry wrote down $600bn in assets and its stock market value plunged $1trn. However, the authorities (the Federal Reserve and the Treasury), ‘on behalf of the taxpayers’, bailed out these errant banks with cash, guarantees and loans worth well over $3trn. Now in recovery mode, there are fewer banks but they are bigger and are up to their old tricks just as much as before.

Take the UK banks: Barclays has been fined $450m for its part in the so-called Libor scandal, where banks’ traders colluded to fix the interest rate for inter-bank lending, which sets the floor for most loan costs across the world. That rigging meant that local authorities, charities and businesses ended up paying more than they should for loans. HSBC was indicted by the US Congress for laundering Mexican drug gangs money and breaches of sanctions on Iran (as was Standard Chartered). Lloyds Bank, along with all the other banks, has had to compensate customers for misselling them personal injury insurance to the tune of £5.3bn, money that could have been better used to fund industry and keep loan terms down.

On the contrary, the banks have shrugged off all these scandals. JP Morgan continued to run a risky trading outfit out of London engaged in outsized trades in derivatives, the very ‘financial weapons of mass destruction’ (to use the world’s greatest investor,Warren Buffet’s term) that triggered the 2008 crisis. The ‘London whale’, as it was called, eventually lost the bank $6bn! And remember, this was in 2012, not 2008. The main trader, Bruno Iksil, told his senior executives that he was worried about the “scary” size of the trades he was engaged in. But they ignored him. And the US supervisors of the bank, the Office of Comptroller of the Currency, supposedly now closely monitoring the banks, also did nothing. By March 2012, the trading losses were mounting and made public but still JP Morgan’s chief executive Jamie Dimon said that the matter was just “a tempest in a teapot”.

This response was typical of bank management. Bob Diamond, the former head of Barclays, eventually sacked over the Libor scandal, but only because the Bank of England governor, Mervyn King insisted, made the statement that “For me, the evidence of culture is how people behave when no one is looking”. Exactly, and it is clear what the banking culture is, namely to use customers money, taxpayers cash and guarantees and shareholders investments to try to make huge profits through risky assets and then pay themselves grotesque bonuses. And nothing has really changed. Only this week, the head of Barclays’ private wealth management section was sacked because of “cultural shortcomings” in his section. Apparently, a secret report had found that the bank engaged in getting “revenue at all costs” and employed “fear and intimidation” on staff to do so. This report had been suppressed by the head of the division, who was a close ally of Bob Diamond.

And that’s still not the end of it. It has now been revealed that during the financial collapse when Barclays was threatened with partial nationalisation, that the Barclays board loaned money to Qatar who then invested in the stock of the bank to the tune £12bn. In this way, the bank avoided state control by issuing more loans! It is still not clear what “commissions” were paid to Qatari investors. Dexia, the Belgian bank, eventually forced into nationalisation, also tried the same trick in 2008 and so did the rotten Iceland bank, Kaupthing, which ‘lent’ money to a Qatari royal who invested it back into the bank. The Qataris took ‘commission’ and if the shares were worthless, it made no difference to them. It just added to the losses of the bank and to the cost to the taxpayer in any bailout.

And I nearly forgot Monte dei Paschi di Siena. This venerable old bank from the heart of Italy was found to be using two sets of accounts to hide the fact that its uncontrolled derivatives division had lost over €700m in trades. This very old bank with a supposed tradition of safe banking was engaged in just the same of sort of risk-taking as the others. And again, the regulators, this time the Bank of Italy, claim they knew nothing about it until the bank pleaded for money from the taxpayer to save it from bankruptcy. The current head of the European Central Bank, Mario Draghi, was head of the Bank of Italy at the time.

Nobody has been charged for these immoral and probably illegal activities. Instead, what has happened is that rank and file bank workers, most of whom have not been involved these scandals and risk taking ventures, but just do work in back offices or at counters, have been sacked in their thousands to reduce costs. And more jobs are going each month.

The extent and nature of these continuing scandals have forced even supporters of ‘free markets’ and the City of London, like former finance minister under Thatcher, Nigel Lawson, to call for the full nationalisation of RBS! The bank is already 82% owned by the taxpayer, but that means nothing because the taxpayer has no say in how the bank is run, what bonuses are paid and what the bank does with deposits, loans and investments.

That’s because the government does not ‘interfere’ and stays at ‘arms length’, waiting indeed to reprivatise the bank as soon as possible. It has not done so, so far, because RBS shares remain so low that the taxpayer would lose something like £30bn on its original purchase of shares. However, Lawson now says, that far from privatising it, the bank should be fully nationalised and the government should intervene in the bank to “turn it into a vehicle for increasing lending to business”. Lawson went on to say that the banks ‘talk the talk’ about conducting themselves properly from now on but behind the scenes they apply huge lobbying to avoid any further regulation or increased liquidity ratios and risk control.

As we have seen, that lobbying has worked, as the G-20 financial stability board has backed down and relaxed and delayed tighter regulation (see my post https://thenextrecession.wordpress.com/2013/01/07/banking-business-as-usual/). Lawson commented “I don’t think the government needs to be frightened of the banks in the slightest. One hears from time to time of threats that they will up sticks (i.e. leave the UK), but that’s a load of nonsense”.

Behind the scandals lie the more significant questions of: what are banks for and are they adding any value or service to society? This issue is hidden in a veil of complexity by bank boards. They try to claim that they are such complex institutions that only extremely highly paid and clever people can run them. Well apparently, that has not worked out so well. The accounts of the major banks are, in the words of one of the world’s leading banking analysts, Meredith Whitney, “incredibly hard to read”. And yet as Whitney says, it’s not really that difficult; “after all, banks make money by selling products and the margin on those products, same as any other business”. But we also know that these overpaid bank executives have no idea of the fire they are playing with when they push the resources of the bank into various risky trades ans assets. The financial regulators try to work out how to measure the risk involved in holding various assets like loans, mortgages, bonds and the derivatives of these assets. But a new report by the world’s bank regulators found that there was not just not enough information to judge whether a bank has taken on too much ‘risk’ or not (bcbs240). They reckoned that banks’ risk measurements could be off by as much five times! God help us.

Recently there has been a debate among mainstream economists about whether the finance sector adds any value at all to an economy. In the US, the finance sector ‘contributes’ 8% of all income in the economy. In a new paper, two scholars charted the rise of the finance sector, which, surprise, surprise, was not in more lending to industry or households, but in creating mortgage backed assets and other exotic financial instruments to sell toxic rubbish to each other (Growth_of_Modern_Finance). What the study shows is that much of banking has not been to help industry and households, but to engage in ‘trading’, which basically means, in the words of Michael Lewis book, Liar’s Poker, the “ripping off of fools”.

Financial markets are inefficient in allocating credit and savings (http://www.voxeu.org/article/why-financial-markets-are-inefficient) and the finance sector is inherently unstable and liable to collapse (Minsky, Shiller etc.). Above all, far from adding ‘value’ to an economy, the sector reduces the available resources for productive (in the capitalist sense) investment and instead channels surpluses into fictitious capital and much of these capitals are ‘value destroying’ activities.

The neoclassical economist, John Cochrane, has sort to argue that this is nothing to worry about because eventually such investment is eliminated by the rational forces of the market (size_of_finance). The problem is, even if the market can allocate resources ‘efficiently’ as the neo-classical school claims, the experience of the rise in the financial sector in the last 30 years is that it can take an awful long time to do it. And then it only ‘rationalises’ these fictitious investments ‘out of the market’ by financial collapse and the ‘collateral’ destruction of productive capital and labour too.

What the continuing banking scandals show is that the global banking system has not really changed its culture or its raison d’etre and it cannot. It must drive the bulk of its activities towards maximising profits and that means towards areas that have higher risk and not towards ‘low margin’ loans to industry of households. And the so-called regulators cannot reverse this. They have been lobbied and badgered by the banks not to ‘restrict’ their activities ‘too much’ or make them hold too much cash or capital to cover losses because that will not make them profitable. And commissions set up to recommend drastic restructuring of the banking sector (Vickers in the UK, Volcker in the US), like breaking them up so they are not ‘too big to fail’, or dividing banks into retail and investment operations, have been shelved or ignored. Nigel Lawson’s solution remains the only practical and effective way of turning the banking system into a service for society not a value-destroying monster. See the pamphlet by the UK’s Fire Brigades Union on the arguments for the public ownership of the banks (s-time-to-take-over-the-BanksLR.pdf).

And the Netherlands has just nationalised SNS Reaal, the fourth-largest systemically important bank in the Netherlands, at a cost to Dutch taxpayers of €3.7bn, after takingheavy losses in its real estate holdings, particularly in Spanish assets. The state will inject €2.2bn in new capital, while forgiving €800m the bank still owed from its earlier bailout during the financial crisis. It will also write off €700m in the value of the bank’s real estate assets. In addition, the government will levy a one-time tariff of €1bn on Dutch banks in 2014 as a contribution to restoring the health of the financial sector. But bondholders will be protected.

4 Responses to “The never-ending banking story”

The themes and conclusion touched by mainstream economists seem obvious, frivolous or childish when compared to what is in the Capital. I don’t doubt that these people are not smart, so, are they, what, frightened by Marx?

Another good read. Would just make one minor point. When you say that as a result of the Libor scandal “local authorities, charities and businesses ended up paying more than they should for loans” it would more accurately be said that ‘they received less interest on deposits’. Since as far as I remember the Libor rates were on the whole manipulated downwards rather than upwards.

I take exception with only one thing stated in your article, Michael – that ” these overpaid bank executives have no idea of the fire they are playing with when they push the resources of the bank into various risky trades ans assets.” I totally disagree – they have enough experience and political savvy to know exactly what they are doing, and knowing they are backed by government largesse (“taxpayer money”) satisfies their goal – the redistribution of wealth upward (that they have helped create). It is purposeful and direct, not unconscious at all. For you to give them a pass in this regard is to partly excuse the crime, to parrot a criminal saying “I only meant to get what I needed – i didn’t mean to hurt anyone”. Class warfare is class warfare – consciously murderous.

Sure, it is conscious policy but the bankers also did not realise that their wonderful profit making risk free programs were no such thing. of course, as you say, as they have been bailed out of their last lot of disasters, maybe they think they can do it again.